In the development of new business models for mobile and online commerce, some see micropayments as a crucial element that promises a lot, yet remains elusive. While micropayments could allow, for example, new media models where a user can pay a very small amount to read an article, the problem lies in the costs – on top of the percentage-based fee they charge, credit card companies also levy a base fee for each transaction. If the publisher wants to charge 10 cents for reading an article on a one-off basis, that’s not going to happen when the card company’s base fee itself is 10 cents.

Enter Coinbase, the Union Square Ventures-backed Bitcoin wallet and exchange service. In a blog post on Monday, Coinbase CEO Brian Armstrong said his company had enabled Bitcoin-based micro-transactions that come with zero fees. And the key to making this viable, it seems, is to slightly work around the traditional Bitcoin system.

Going off-block

Quick recap: all Bitcoin transactions get added, in blocks, to what is known as a “blockchain.” This serves as a record of all Bitcoin transactions ever, in order to prevent bitcoins being spent twice. The mechanism of packaging up and verifying these blocks also provides a way for new bitcoins to enter the ecosystem, through a process known as “mining”.

Now, the “miners” need powerful hardware to do their thing, and that doesn’t come for free, so they also levy a “miner fee” – typically between 1-5 cents — on all transactions. According to Armstrong, Coinbase usually absorbs these miner fees on behalf of its customers, as long as the transactions in question are above a certain amount.

That system clearly doesn’t work with micropayments, so what Coinbase has done is to take these very small transactions off the blockchain — they are only possible between two Coinbase accounts, so they don’t need to bother the overall Bitcoin ledger. Once the payee (perhaps a publisher who might use a service such as Bitwall to accept payments on its site) has accumulated a minimum of 0.01 bitcoins (roughly $1) through micropayments, they can then “send it back on the blockchain”, Armstrong explained.

As he described the benefits:

“Traditional display ads that worked so well on desktop/laptop displays don’t have enough screen real estate on mobile devices and haven’t worked as well. Paid content (entertainment, games, apps, and in-app purchases) seems to be the business model that will win, but these are almost all micro-transactions with expensive fee structures. This is part of the reason you see such high % fees (in the 30% range) on in app purchases across iOS, Android, Facebook, and other platforms.

“Bitcoin has the potential to help this problem by generally lowering fees. But things get really powerful with off blockchain transaction like we launched today, because it literally brings the fees down to zero.”

Taking micro-transactions “off-block” is probably a good thing for the blockchain, which is almost 9GB in size now. Bear in mind that many locally-stored Bitcoin clients (as opposed to third-party wallet services) store a duplicate of the blockchain. There’s also the factor of the Bitcoin network having anti-flooding algorithms built into it, which may not play so nicely with high volumes of very small amounts.

Indeed, Coinbase isn’t the first operation to note these problem and try to work round them – at the end of June, the Java-based Bitcoin client project Bitcoinj also suggested a new protocol for setting up Bitcoin micropayments channels.

Proving Bitcoin’s value

As I said back in April, the great thing about Bitcoin is not necessarily this particular crypto-currency itself – it’s the way in which Bitcoin is stimulating and developing the virtual currency space as a whole, with the wider benefit being the disruption of the traditional financial system.

Banks levy usurious fees on international money transfers, and virtual currencies make it possible to severely undercut them. The card companies hold back the development of much-needed micropayments ecosystems, and perhaps virtual currencies can work their magic there too. This is why, hype and speculation aside, Bitcoin really does matter.